Those efforts stretch back 18 months, when the manager began selling some of Woodford Equity Income’s unquoted stocks to other funds he runs, as he sought to keep his flagship fund under the City regulator’s 10% limit.

Around the same time, unquoted Ibiza property developer Sabina Estates suggested a Guernsey listing for Woodford’s stake as a means for the manager to continue investing, an arrangement he has since replicated with Benevolent AI, Industrial Heat and Ombu.

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Woodford’s manoeuvres have enabled the manager to navigate a period when the Equity Income fund’s unquoted exposure has been flashing 'red' on the fund group’s own internal monitoring system as investors have pulled money amid poor performance, only easing to 'amber' with this month's swap deal.

Switches between funds

Signs of the challenge Woodford (pictured) has faced to keep the fund below the 10% unquoted limit began to tell in late 2017, when the manager sold £48.8 million of his Equity Income fund’s stake in Benevolent AI, his biggest and best-performing unquoted holding, to his Patient Capital investment trust.

That transaction was not signposted to investors, despite the manager’s public commitment to transparency, reflected in his publishing of all the stocks held by his funds every month. Woodford Investment Management said the Equity Income fund’s reduced stake ’would have been evident in the portfolio holdings we publish each month in full’.

Patient Capital already had a small position in the artificial intelligence developer. The trust paid in cash for the chunk of the Equity Income fund’s stake in November 2017, installing the company as its third largest holding.

‘Patient Capital has always been a willing buyer and given there are limited new shares available, to attain a bigger exposure to this business it needs to buy shares from the Equity Income fund or another existing shareholder,’ said a Woodford spokesman. ‘But there wasn’t an opportunity to add to it until the income fund became a more willing seller.’

That transfer was the biggest in a series of unquoted company sales by the Equity Income fund to both the Patient Capital investment trust and the Omnis Income and Growth fund Woodford runs for national financial advice group Openwork.

In the same month, the Equity Income fund offloaded a smaller £2.5 million stake in Oxford University spin-out Genomics to the trust. In December that year, Patient Capital bought a £6.3 million stake in drug maker Mission Therapeutics from the fund.

Omnis Income and Growth bought a £2.7 million stake in Benevolent AI from the Equity Income fund in September 2017.

A Woodford spokesman said these unquoted company sales between funds were one of the options for the fund manager in dealing with outflows and the different investment restrictions across his mandates, alongside selling to other investors or the companies listing on the stock market.

‘The process for these trades is clear and very strictly adhered to and our pre-trade compliance checks need to be completed before a transaction can proceed,’ he said.

Woodford Investment Management emphasised that the pricing of the Equity Income fund’s unquoted holdings was determined by its authorised corporate director, Link, and verified independently. Sales of unquoted stocks to Woodford’s other funds were only allowed if the holding had been valued within the last two months, and Link was required to approve the trade, it added.

Start-ups complicate withdrawals

Managing unquoted exposure has been an additional complication to Woodford’s difficult challenge in dealing with heavy withdrawals from his fund as his performance has deteriorated.

His Equity Income fund is down 8.8% over the last three years and is rooted to the bottom of the Investment Association’s UK Equity Income sector over that period, as heavy share price falls for the likes of Provident Financial (PFG), Capita (CPI), Prothena (PRTA.O) and Allied Minds (ALML) have weighed.

The fund has more than halved in size, from a peak of £10.2 billion in May 2017 to £4.7 billion at the end of last month.

Woodford has funded redemptions largely by selling some of his larger, listed holdings. Poor performance of many of these stocks, coupled with their sale, has combined with big jumps in valuation for a number of the manager’s unquoted stocks to inflate the relative size of the off-market positions in his fund.

That has resulted in some of his best-performing unquoted stocks growing to heavy positions in his fund. Benevolent AI, up by more than 600% since Woodford’s first investment in the company, is his Equity Income fund’s sixth largest holding, accounting for 4.1% of the fund. His controversial stake in cold fusion specialist Industrial Heat, which jumped 357% in a revaluation late last year, has grown to a 2.3% position.

Neither are stocks the manager wants to sell. But keeping hold of them in his Equity Income fund has been a challenge, given the threat the heavy weightings to which they have grown posed to the 10% limit.

Guernsey listing plan

The solution to this problem came from an unlikely source, in the form of Ibiza property developers Sabina Estates. The unquoted company suggested Woodford list his investments in its shares on Guernsey’s stock exchange as a means of continuing to provide funding.

The listings, amounting to a combined £425 million, or 9% of his Equity Income fund, have enabled Woodford to keep below the Financial Conduct Authority’s 10% limit on the amount of unquoted company stocks a fund can hold. Without them, his equity income fund’s unquoted exposure would stand at over 16%.

‘We want to maintain our exposure to these businesses and they want us to remain an investor,’ said a Woodford spokesman.

‘Where there is an investment that we have strong conviction, we will want to hold on to it for longer and continue working with the company to generate value. It is what we do as patient capital investors and there are options that enable us to hold onto stocks and remain within the regulatory limits.’

The listings are a far cry from the flotations Woodford has talked up for his unquoted holdings, like the soaring initial public offering (IPO) of biotech company Autolus (AUTL.O) on the US Nasdaq index last summer.

But they allow the manager to cling on to some of his best-performing stocks ahead of potential further developments, such as a major market flotation or a bid.

‘Many of these businesses are maturing companies and at some stage we would expect a crystallisation event,’ said a Woodford spokesman.

‘Selling these holdings before they have the opportunity to realise their potential and value would not be delivering on investors’ expectations in our view.’

In the case of the manager’s stake in Industrial Heat, listing was swift, triggered by the stock’s revaluation 357% higher at the end of September and admitted to the exchange two weeks later.

Others have been longer in the planning. Benevolent AI cancelled and then reissued Woodford’s shares in March last year, together with a commitment to list them.

That meant that the stake no longer counted towards the unquoted limit. Under the FCA’s rules, ‘recently-issued securities’ do not, provided that in the terms of the issue, the company has committed to list within 12 months.

Benevolent left it late to deliver on the pledge, listing its shares one day before the 12-month deadline. As did Proton Partners (PPI), the biotechnology company which listed on the NEX Exchange last month, a year to the day after it committed to doing so in cancelling and reissuing Woodford’s shares.

‘The reissuing of shares allows investors, such as us, to secure, within the terms of such issue, an undertaking that the company shall apply to list those shares,’ said a Woodford spokesman.

‘This process can be viewed as an “insurance policy” that the company is committed to the plan.’

Breach 'cannot occur'

The fund group is insistent that the strength of its rules and processes means that an active breach of the FCA’s 10% rule, where the fund crossed the threshold by buying too many shares in unquoted companies ‘does not and cannot occur’.

‘We monitor the 10% level on a daily basis, as we do all our investment restrictions,’ said a spokesman.

A passive breach, where unquoted positions grow to over 10% of the fund without the manager adding to his positions, could not be ruled out. Upwards revaluations to the unquoted stakes, share price falls for listed stocks or heavy redemptions could trigger this.

Woodford Investment Management said it imposed moratoriums on the fund buying additional stakes in unquoted businesses when it assessed a heightened risk of such a breach.

Such a restriction was put in place ahead of the launch of the Woodford Income Focus fund in early 2017, amid concern Equity Income investors could move to the new fund, but lifted three months later after minimal switching.

Were the fund to commit a passive breach of the 10% rule, Woodford would be required to bring his unquoted positions below the limit as soon as possible, with the FCA likely to impose a deadline of up to six months.

Woodford said it was confident of being able to do so ‘in a manner that is consistent with our investors’ best interests’ by selling unquoted holdings to other Woodford funds and other investors, or reviewing their readiness for listing.

So far Woodford has only sold two of the Equity Income fund’s unquoted holdings to other investors. In February last year the manager offloaded his stake in AJ Bell (AJBA) prior to the online stockbroker’s flotation to his old employers Invesco. The following month, he sold his stake in rural broadband provider Gigaclear to M&G.

These two sales raised a combined £60 million for the fund. The fund has offloaded more than double that, £130 million, in unquoted stock sales to the Patient Capital trust, through the switching of stakes in Benevolent AI, Genomics and Mission Therapeutics and this month’s asset swap.

More swap deals on cards

Further swaps deals with the trust are planned, provided the Patient Capital board secures shareholder approval for more share issuance.

But that route is likely to be finite. Under FCA rules, funds cannot control 20% or more of the voting rights of a single company and this month’s deal installed the Equity Income fund as the owner of 9% of Patient Capital’s shares.

Funds can hold more than 20% of the shares if they restrict their voting to below that limit, a mechanism Woodford has employed with a number of smaller companies where he is the dominant investor. But Woodford Investment Management is not planning to do so with the trust.

Nevertheless, Woodford Investment Management expects to remove the majority of the Equity Income fund’s direct unquoted company exposure over the next 12 to 18 months.

Some of the larger, more mature unquoted business will remain, however. The listing of Woodford’s stake in Benevolent AI in Guernsey looks to have cemented its place in the fund, while other big unquoted positions, like Oxford Nanopore, a 2.4% holding, and Immunocore, a 1% position, are likely to remain.

The fund group has insisted that the swap deal was a response to client demand to reduce the Equity Income fund’s unquoted holdings, not prompted by the 10% unquoted assets limit.

‘This was not to avoid breaching and had the transaction not taken place, we would have remained under the 10% limit,’ said a Woodford spokesman. FCA rules dictate that funds should not invest ‘in units of a closed-end fund for the purpose of circumventing the investment limits’.

The structure of the deal, in which the fund has received shares in the trust rather than cash, means it does not play a role in funding redemption requests. The vast bulk of the cash that has been needed to deal with redemptions has been generated from the sale of quoted holdings.

Investors' flight poses liquidity challenge

Investors have pulled around £3.8 billion from the Equity Income fund since assets peaked in May 2017 and only around £150 million in cash has been received from the sale of the fund’s unquoted assets over that period.

While unquoted companies would be harder to sell than the manager’s positions in larger listed stocks, Woodford Investment Management insisted the manager’s reluctance to offload these positions was down to valuation.

‘When he has to raise cash, the things Neil sells first are the holdings where the price is closest to our valuation target,’ said a spokesman. ‘Market capitalisation considerations are irrelevant in this process.’

Woodford’s listing of his unquoted stakes in Guernsey is unlikely to unlock any further liquidity for his fund. While the stocks, structured as preferred shares and listed on the exchange’s corporate debt section, are tradeable, the move provides a means for Woodford to keep hold of them rather than sell.

Nor so far has the flotation of Proton Partners on the junior NEX Exchange. After the proton beam therapy developer’s IPO at the end of February, not a single share has been traded.

The flotation has instead committed Woodford to further funding, with the manager pledging an additional £80 million over 18 months, although the fund group said that further investment was unlikely to be required.

Woodford Investment Management pointed to the lock-up period applying to the bulk of the company’s shares. Woodford’s Equity Income, Patient Capital and the Omnis Income and Growth fund, together with the Wales Life Sciences Investment fund, cannot sell their combined 49% stake in the company for six months following the flotation. The directors of the business, who own just over 7% of the shares, cannot sell them ‘save in certain circumstances’ for a year.

‘Following expiry of the lock-up period we would expect to see greater potential for trading in the shares,’ said a Woodford spokesman.

The fund group denied that as the major investor in the company, it had driven the decision to float in order to bring down the Equity Income fund’s unquoted holdings.

A spokesman for Proton added: ‘The decision to list has been in our development plans for more than two years and was driven purely by the ambition to grow the company.’

Woodford Investment Management said liquidity of its funds was monitored in real time, shared monthly with the FCA and discussed at least every quarter with authorised corporate director Link and depository Northern Trust.

The fund group monitors the amounts within its funds that can be sold in one day, five days and 20 days and operates green, amber and red thresholds serving as alerts for periods of heightened redemption or asset illiquidity. Stocks are grouped into four ‘buckets’ depending on how liquid, or not, they are.

‘Liquidity is separately monitored and managed and is not linked to where stocks are listed and the exchange they are listed on. We have strict triggers and limits to monitor the liquidity of the fund,’ said a Woodford spokesman.

‘We remain in the green threshold and have done so throughout the sustained period of redemptions.’

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